Exotic Share Buy-Backs

Companies have been able to purchase their own shares, usually referred to as share buy-backs, for 30 years. Indeed, it may well come as a surprise to many readers that there ever was a time when a company could not buy its own shares. Funding constraints often crop up in share buy-backs. They need not hamper a buy-back if an exotic structure is used. 

An individual selling his shares back to a company has two sets of rules to contend with:

1. The Company Law rules; and

2. The Tax rules, if the shareholder wants capital gains tax (CGT) treatment.


The Company Law Rules

The Company Law rules are designed to protect the interests of creditors and other stakeholders in the company. After all, a buy-back will reduce the capital base of a company.

The key Company Law rules include that: (1) the company must have sufficient profits to cover the buy-back (it is possible to purchase shares out of capital, but that is not considered in this article) and (2) the purchase price must be paid in full in cash on completion of the buy-back.


The Tax Rules

The gain made by a shareholder in selling his shares back to a company will be subject to CGT provided the Tax rules are complied with. If not, then the gain is taxed in the same way as a dividend. Most individuals pay less tax if the gain is subject to CGT.

The key Tax rules include that: (1) the buy-back must be wholly or mainly for the benefit of the trade of the company, (2) the individual`s shareholding must be "substantially reduced" (meaning his interest in shares in the company after the buy-back is no more than 75% of his interest before it) and (3) after the buy-back the individual is not "connected" with the company (meaning he cannot after the buy-back have more than 30% of the share capital, share and loan capital or voting rights in the company).

Usually, the individual is retiring from the company or a dispute has arisen. That ensures the commercial benefit test is satisfied. But, what if the company does not have sufficient profits to cover the amount payable for the shares? Or, it does not have sufficient cash to pay for all the individual`s shares in one go?


Exotic Buy-Back Structures

It might still be possible to carry out the buy-back with the best tax outcome if the buy-back is structured appropriately. It is worth considering:

1. Staged buy-backs. Care is needed so that when each buy-back occurs the shareholding is "substantially reduced" and at no stage is the individual "connected" with the company. The staged buy-back can be backed up with cross options.

2. The individual loaning part of the proceeds back to the company. Care is needed to ensure that he does not become "connected" with the company by virtue of holding more than 30% of the share and loan capital of the company.

3. Agreeing to sell all his shares, but having staged completion of the purchase of the shares. If properly documented, the individual will have parted with the beneficial ownership of the shares when the contract to sell is entered into. That ensure he satisfies the Tax rules. The Inland Revenue (as they were then called) in a meeting with ICAEW in November 1987 accepted that a single contract with staged completions of buy-backs is valid tax planning. The arrangement also satisfies the Company Law rules as there are several completions of buy-backs and at each completion the shares being bought back are paid for in full.

The conditions to qualify for entrepreneurs` relief from CGT, which can result in a 10% tax rate, might see increased use of structure 3.

If you have any questions about share buy-backs, CGT, entrepreneurs` relief or any other company law or tax issues, please contact Nasim Sharf on 01482 337336, email nasim.sharf@rollits.com

Posted on: 02/09/2011

This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.

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